ABC analysis is an inventory management technique of categorising items according to their importance to the business. ‘A’ items are typically the fastest moving, or have the highest sales. ‘B’ items are medium fast-moving, or have medium sales, whilst ‘C’ items are slow-moving or have low sales. The segmentation then determines how each category is treated to drive efficiencies across the supply chain.
The practice originates from the Pareto principle, whereby 80% of the output from a given situation is determined by 20% of the input. In other words, prioritising your focus on a small range of items can yield better results than treating all items equally. ABC classification is used right across the supply chain from upstream demand planning, to warehousing and in-store ranging.
How Do I Perform ABC Analysis?
ABC Analysis can be carried out in only a few steps. Create a table showing each SKU or item by the metric you want to categorise against; in a warehouse, for example, this is likely to be pick units or pick lines. Sort the data in descending order of your metric (pick units) and then calculate the percentage each SKU contributes to the total. Then create a table from 0-100% and sum the amount of the metric for each percentage of SKUs cumulatively.
This can be charted to understand how steep or gentle the curve is. The steeper the curve, the more concentrated the activity in a smaller range of SKUs. The chart shows a client with a 84:20 pareto, which is slightly more aggressive than the typical Pareto curve. The gentler the curve, the more spread the activity over a larger range of SKUs.
The next step is to divide the items into ABC classifications. A typical profile is:
- A items – SKUs in top 80% of demand
- B items – SKUs in the 80-95% of demand bracket
- C items – SKUs in the bottom 5% of demand
Once items are categorised accordingly, they can then be managed appropriately based on their importance to the business. The rest of this article outlines how these items might be managed differently.
Use Case 1: Demand Planning
Demand planners will manage the inventory and purchasing for potentially thousands of SKUs, as was the case when I was working in the automotive sector. It is simply not possible to manage each SKU individually and so by creating ABC classifications, a planner can focus on the items that really matter to the company’s availability and working capital targets.
ABC classification will determine how frequently the SKU is reviewed manually, how often orders are placed on a supplier and how big each order is. ‘A’ items tend to be reasonably stable in demand so stock covers might be run slightly lower than ‘C’ items where minimum order quantities (MOQ) apply or demand is more erratic.
In some environments, it can be useful to classify SKUs or items based on two characteristics such as Speed of Movement and Value of Goods; or Speed of Movement and Predictability. This creates a matrix that, as shown in the table, to add further nuance to how parts are managed.
For example, two products might be ‘A’ items in terms of speed of movement but have wild cost differences. In such a case, it is important to give the same attention to both SKUs as they have an equal impact on the customer but apply slightly different order frequencies as overstocking on the more ‘AZ’ item will have a more significant impact on working capital that the ‘AX’ item. In reality, some of these inventory strategies can be overruled by other factors like supplier lead times and demand volatility when managed by specific demand planning software algorithms.
The advantages of ABC classification in demand planning environments include higher levels of availability to internal or external customers, lower cost inventory holdings to free up working capital, reduced supply chain noise in the form of fewer purchase orders (PO) and streamlined workload for the planners themselves.
Use Case 2: Warehousing
The warehouse might use ABC classification slightly differently. In this case, the number of visits to a bin might be more important than the number of units picked out of it, as the bin visit is the more costly part of the process in time and therefore labour cost. It is possible in some environments to use ABC Analysis as part of a Bin Slotting exercise.
This is the regularly quoted concept of keeping your fastest movers closest to the doors or start of the pick walk to minimise the amount of movement on the putaway and picking process and boost efficiency. A visualisation of the principle is shown below.
The implementation of this strategy does present complications, however. Setting up the pickface and keeping it up to date takes time and effort although rules can be set in the Warehouse Management System) to automate this to a certain degree but there will always be some SKUs where demand drops substantially, and the SKU needs manually relocating to a slower area of the warehouse.
The largest obstacle to using ABC classification in the warehouse is volatility and predictability of demand on SKUs. Slotting works very well in operations with stable demand profiles; for example, in the automotive or aerospace sector where SKUs have long lifespans and do not change classification often. This is more difficult in the retail sector where SKUs have short lifespans, are prone to surges in demand as fashion trends emerge and the cost of managing the pickface outweighs the benefits. In such cases, splitting the pickface into zones by ‘New’ and ‘Non-New’ might be a viable strategy.
The advantages of ABC classification in the warehouse could include improved productivities and therefore lower costs in putaway and picking. It’s important to consider the density of the activity to avoid too many operatives working in the same small area, getting in each other’s way.
Use Case 3: In-Store Ranging
In-store ranges can be determined based on similar methodologies to ABC classification. It’s important to have high availability of the products that will generate high footfall. Some businesses will different sized stores across the store estate and so will have different stock ranges; for example, think about Tesco Express, Tesco and Tesco Extra. Tesco Extra will hold the full range while the other formats have limited capacity and so a mixture of profitability, consumption and supplier promotions will determine ranging.
ABC classification is a valuable tool to understand the shape of a business’ inventory and demand. It can be used across the supply chain to drive better performance and efficiencies. Whilst it is useful tool, it will not solve problems by itself, but it can drive supply chain and logistics teams to make better decisions and prioritise workload. It should be used accordingly, where appropriate.
BoxLogic is a specialist logistics consultancy and supports our clients to make strategic decisions and by using a range of analytical tools, including ABC classification, as well as modelling techniques. If you need support plotting the future of your logistics operations, then contact us today.